The money that you earn from your savings account is just gravy on top of what you’ve already saved.
It feels like free money. That’s why it can be such a shock when you find out that yes — paying taxes on interest is something you need to do.
The amount you actually owe in taxes will depend on two factors: how much interest you earned and your tax bracket. We’ll break down how to find out how much you owe and how to reduce your tax bill so you don’t have to worry about paying taxes on interest.
That way, your taxable interest won’t give you any surprises come April 15.
What is Taxable Interest Income?
It may not seem like you’re earning a significant amount from your savings account. But collectively speaking, that’s a lot of money the IRS is missing out on every year among all Americans who pay taxes.
That’s why the IRS requires you to report — and pay taxes on — the interest that you earn from your bank accounts. The IRS treats that money exactly the same as if your employer paid it to you in the form of wages.
How much interest income do I have to report?
Knowing how much interest is taxable is easy: all of it is taxable.
If you file a tax return at all, you’ll also need to report the interest you’ve earned on your bank accounts.
Your bank makes this easy for you. It’ll send you Form 1099-INT at the end of the year if you’ve earned more than $10 in interest. This form specifies exactly how much interest you’ve earned. That way, you don’t have to tally it up yourself. Simply report this number on your tax return, and you’ll be all set.
Even if your bank doesn’t send you a Form 1099-INT because you earned less than $10 in interest, you still need to report any interest income on your tax return.
How the tax rate affects your savings account interest
Your tax rate will depend on two things: your income for the year and how much interest you earned on your accounts.
Your income determines which tax bracket you fall into.
For 2020, here are the income tax brackets based on your filing status:
To find out how much you’ll owe in savings account interest tax, you need to find out which tax bracket you fall into. Multiply your interest income by your tax rate to calculate how much you’ll owe in taxes from that interest.
For example, let’s say that Jim and Pam earn $75,000 per year together from their day jobs. They file their taxes jointly, so this puts them in the 12% tax bracket. Let’s also say they earned $200 in interest from their high-yield savings account.
To calculate their bank account interest tax, they’d simply multiply $200 by 0.12, which would equal $24. Jim and Pam would owe an extra $24 on their taxes as a result of their bank account interest.
As you can see, even if you fall into a higher tax bracket, you probably won’t owe a huge amount of money on your bank account interest. Most people don’t earn much interest to begin with. Even if the fraction you owe in taxes is large, the overall tax due probably won’t be.
How to Avoid Paying Tax on Savings Account Interest
Still, if you’d rather not pay any extra taxes on that money, or if by chance you really did strike it big with your interest income, there are many ways you can lower your tax bill so you don’t even have to worry about paying taxes on interest.
Each of these methods relies on lowering your overall tax bill — not your taxable interest specifically. By lowering your overall tax bill, you can cancel out any taxes you may have owed as a result of your taxable interest income.
Even if you don’t have to pay any bank account interest tax at all, you can still use these techniques to lower your overall tax bill and maybe even get a tax refund.
Contribute to a traditional IRA
Traditional IRAs are excellent savings accounts to use for retirement. Plus, any money you put into them now can be written off on your taxes. You can contribute up to $6,000 to your traditional IRA in 2020. If you’re 50 years of age or older, your contribution limit is capped at $7,000.
So if you earned $50,000 during the year and contribute the maximum amount for people under age 50, you only need to pay taxes on $44,000 worth of income. And that’s not including any other deductions you may qualify for.
There are some limits to this, however. If your workplace offers you a retirement plan and you earn more than the maximum threshold ($65,000 for single filers or heads of households, $124,000 for couples filing jointly or widowers), then you’ll only be able to deduct a part of your traditional IRA contributions.
Similarly, if only your spouse is covered by a workplace retirement plan, those deductions start being phased out at $196,000 if you file taxes jointly.
Workplace retirement plans
If your workplace offers a retirement plan such as a 401(k), a 403(b), a 457, or a Thrift Savings Plan, you can also lower your taxable income by contributing to these accounts. For 2020, you can contribute up to $19,500 to these accounts.
Health Savings Accounts (HSAs)
If you are covered by a High Deductible Health Plan (HDHP), an HSA is another great way to lower your tax bill. These accounts let you set money away for certain health care expenses such as doctor’s visits, prescription medicine, lab tests, and surgeries.
More importantly, any money you put into an HSA can be deducted from your taxable income. For 2020, you can contribute up to $3,550 for a single person or $7,100 for a family.
Bank Account Interest Tax FAQs
These answers to commonly asked questions about bank account interest taxes should help clear your final concerns on the matter.
Always Pay Your Taxes When They’re Due
Paying taxes on your taxable interest doesn’t have to throw a wrench in your plans.
Even though you do have to pay taxes on this income, most people will only owe a small amount in taxes. That’s because most people just don’t earn much interest on bank accounts.
Paying taxes on interest is inevitable. The most important thing is to file your tax return and pay your tax bill by the tax deadline. One thing’s for sure: you won’t want to pay any tax penalties as a result of filing or paying your taxes late. Late fees would likely be more than the amount you actually owe in savings account interest tax itself.